Dollar climbs on surprisingly strong retail sales

Yen under pressure on fading expectations of interest-rate hike next week

By

WanfengZhou

NEW YORK (MarketWatch) -- The dollar rallied Wednesday, touching a three-week high versus the yen, after a government report showed retail sales increased much more than forecast last month, easing concerns over a hard-landing of the U.S. economy.

The Commerce Department said seasonally adjusted U.S. retail sales increased by 1% in November, the largest gain since July. Excluding the 0.9% gain in motor vehicle sales, retail sales rose 1.1%, the largest gain since January. Economists expected a 0.2% gain in the headline and a 0.3% increase in sales excluding autos. See full story.

"The number was fairly strong in light of the way the market was set up yesterday because the Fed's policy statement was seen as dovish," said Mike Malpede, senior currency strategist at Man Global Research. The report was seen as "reducing the odds of a recession."

Late in New York, the dollar was quoted at 117.51 yen, compared with 116.76 yen late Tuesday, after touching 117.64, the highest level since Nov. 22. The euro changed hands at $1.3213, vs. $1.3277.

The British pound traded at $1.9671, down from $1.9703. The dollar changed hands at 1.2057 Swiss francs, compared with 1.1996 francs.

Rising 10-year Treasury yield also offered support. "The rally in bond yields in the wake of the retail sales suggested the bond market is undergoing a sea-change in expectations and this is going to spill over into the dollar eventually," said Brian Dolan, director of research at Forex.com, a division of Gain Capital. See bond report.

Rate outlook

The odds of an interest rate cut in early 2007 declined Wednesday, the federal-funds-futures market showed. Traders were pricing in a 20% chance that the Federal Reserve would lower interest rates to 5% in March. The odds of a rate cut were at 28% late Tuesday, and as high as 76% on Dec. 1.

The U.S. currency fell against the euro Tuesday after the Federal Open Market Committee held its benchmark federal funds rate unchanged at 5.25% and downgraded its assessment of the housing sector.

The Fed's accompanying statement said that "some inflation risks remain" and that the cooling in the housing market has been "substantial." The Fed also noted that it expects a moderate pace of growth "on balance" in coming quarters, although "recent indicators have been mixed." See full story.

Economists at Bear Stearns said they continued to expect another interest-rate rise from the Federal Reserve.

"The next move from the Fed is more likely to be a hike rather than a cut given the implied tightening bias on concerns about the outlook for inflation and given our expectations for a rebound to trend-like growth in 2007," they said.

December weakness

The dollar is "near the end of its current rally" and may "drop further towards year-end, consistent with the seasonal weakness observed in recent years," said Nick Bennenbroek, senior currency strategist at Brown Brothers Harriman, in a note.

Major economic releases over the second half of December will focus on manufacturing and housing sectors, which seem "less likely to provide fuel for dollar strength," he said. "We do not envisage investors pricing in expected Fed tightening at this stage," so "further dollar support from changing monetary policy expectations will be limited."

Man Global's Malpede said the U.S. currency may fall to around 1.35 per euro and $2 per sterling by the end of the year.

But Amarjit Sahota, a currency strategist at HIFX, expects the dollar to rise to about 1.31 per euro and 118 versus the yen by year-end. The Federal Reserve will be "on pause longer than anticipated...maybe as far as June" 2007, he said.

U.K. jobs data

Elsewhere, the British pound rallied before surrendering gains after an unexpected decline in U.K. unemployment data fueled speculation the Bank of England would raise interest rates early next year.

The claimant count measure of unemployment fell 5,700 in November, the largest drop since January 2005. The unemployment rate was steady at 3% in November. Economists forecast an increase of 4,000.

"The news was strongly bullish for the pound as it indicates that U.K. economy remains remarkably resilient and labor markets are tight," said Boris Schlossberg, senior currency strategist at FXCM. The Bank of England "may have to consider another rate hike at the beginning of next year."

The yen remained under heavy pressure, hitting fresh record lows versus the euro, after recent soft economic data and news reports amid fading expectations the Bank of Japan would raise interest rates next week. Market talk that the Japanese government may make downward revisions to gross domestic product growth for 2006 and 2007 further weighed on the currency.

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